Succession Planning Guide For Family-Owned Businesses: Part 1

Succession Planning Guide For Family-Owned Businesses: Part 1

It is estimated that over the next 5 years, nearly 500,000 small family-owned businesses will change hands. Over the next 20 years, equity in businesses expected to change hands represents over $10 trillion in personal wealth.

This trend is not driven by the economy nor is it driven by government regulatory changes. It is driven by the aging of the baby boomers, a group of Americans who were born between 1946 and 1964. 

As family-owned businesses represent the engine of the economy, contributing 57% of the U.S. GDP (that’s $8.3 trillion), employing 63% of the workforce (FEUSA, 2011), and responsible for 78% of all new job creation., the impact of this aging population represents a significant trend.

Business owners of this particular generation find themselves in one of three camps: 

  1. They have an orderly succession plan where they are passing the reins of their business onto their children or employees.
  2. They have children who have no interest in the family business.
  3. They have no children to leave their business to. 

In all three cases, the various implications of transition can be daunting.  

To compound the challenge is the fact many of these owners have no real advisors to guide them through the legal and tax issues surrounding succession planning. And all too often, the planning that is necessary either never happens or is begun too late to be effective.

When a business owner decides that it is time to exit the business, because of the typical type “A” personality of the owner, they often want that decision to take effect immediately. Unfortunately, he or she is 2-5 years away from such an event. 

For those advisors who do not address an exit strategy for their clients and friends in the formation of a legal entity, they do a disservice to their clients. Most business people spend a lot of time in the formation of their business entity on how to split the profits and very little time on how to handle catastrophic events such as the death of a partner, the divorce of a partner, or even the falling out between partners.  

 The implication of a lack of planning can be devastating.

Choose the right team of advisors

Too often the closest advisors are old high school or college friends who have become attorneys, accountants, bankers, or insurance agents. Unfortunately, in most communities where the 6-degree of separation is really 1 degree, business owners tend to keep things very close to the vest. As one attorney told us, I won’t know one of my clients is selling their company until they send me a closing document for review.  

Oftentimes, the sale, disposal, or transfer of the ownership is not an expertise of the advisors. They tend to deal day to day on more routine issues such as contracts, tax returns, and leases. 

Here’s an example of why having a knowledgeable advisor is crucial:

I know of a business owner whose desire to sell his company will cost him $150,000 in additional taxes on a $1,000,000 transaction because he is the sole shareholder in a C Corporation.  Had he converted to an S Corporation 5 years ago, and he did ask about such a conversion back then and was told it wasn’t significant, his tax bill would have been $150,000 less, translating into $150,000 more in his pocket

Advisors also tend to shy away from any discussions about a transfer as they feel they could lose a client and an income stream. In fact, they would simply be exchanging a business account for a high-net-worth individual account.  And the fees to assist in the transfer could well exceed their normal annual fees. Personal financial advisors tend to focus on liquid assets, cash, stocks, and bonds.  The family business may be reflected at a very nominal value on the business owner’s personal financial statements and is therefore either overlooked or ignored.

It is important for business owners to have a team of complimentary advisors available to them that are experts in their respective disciplines. Traditionally, the team would include a banker, an attorney, an accountant with tax law expertise, a personal financial planner, and an M&A (mergers and acquisitions) expert.

As the old story goes,

A man who is lost, calls someone to get directions to his destination. When the person on the other end of the call asks, “Where are you?” and the caller responds, “I don’t know”, the person says “Well I can’t give you directions from “I don’t know”.  

Transition planning is much the same, if you don’t know where you are, then it is very difficult to plan an exit strategy.  Too often there are intermediate action steps a business owner must take to get to a transaction.  And too often, a business owner is persuaded to “list” their company with a brokerage firm much like he would list his house for sale.

Ready to learn the value of your family business?

Knowledge is power. Whether you plan to sell tomorrow or in 20 years, now is the time to discover the true value of your business. Our advisors will help you determine your business value, and craft a strategic roadmap to successfully exit or sell down the road. Schedule a consultation with one of our CAPSTONE business advisors today.